April Deadlines Relating to FICA Tax Treatment of Severance Pay in Quality Stores Are Quickly Approaching

Two deadlines relating to the Sixth Circuit Court of Appeals’ decision in United States v. Quality Stores, Inc., No. 10-1563 (6th Cir. Sept. 7, 2012), are quickly approaching—the deadline for the United States to file a petition for certiorari to the Supreme Court and the deadline for employers to file refund claims.

April 4, 2013 Deadline to Seek Supreme Court Review

On September 7, 2012, the Sixth Circuit held that severance paid to employees on account of an involuntary reduction in force is not subject to FICA taxes, creating a split among the circuit courts on this issue. Specifically, the Sixth Circuit concluded that severance that meets the following five requirements of section 3402(o) of the Internal Revenue Code is exempt from FICA:

1. An amount paid to an employee;
2. Pursuant to an employer’s plan;
3. Because of an employee’s involuntary separation from employment, whether temporary or permanent;
4. Resulting from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and
5. Is included in the employee’s gross income.

The United States requested a rehearing en banc, which the Sixth Circuit denied on January 4, 2013. The United States is expected to seek U.S. Supreme Court review. The deadline for filing a petition for certiorari is April 4, 2013.

Given the significance of the issue, the circuit court split, and the billion dollars claimed by the Internal Revenue Service (IRS) to be at stake, the Supreme Court might decide to hear this case if presented—in which case the ultimate resolution of this issue is at least a year away. If the Supreme Court agrees to hear the case and concurs, employers should be able to obtain refunds for FICA taxes paid on severance to employees on account of involuntary workforce reductions. If the Supreme Court declines to hear the case, the IRS will most likely grant refunds to employers whose principal place of business are located in the Sixth Circuit (that is, Kentucky, Michigan, Ohio, and Tennessee) and continue to contest refund claims elsewhere. However, in order for any employer to obtain a future refund based on Quality Stores, the employer must file a refund claim.

April 15, 2013 Deadline to Preserve FICA-Tax Refunds

All employers that have paid severance in connection with involuntary workforce reductions should consider filing refund claims, even if their principal place of business is not located in the Sixth Circuit or they did not provide severance under a formal plan. The “plan” requirement is discussed below.

To preserve a future refund based on Quality Stores, an employer must file a refund claim before the applicable statute of limitations expires. In general, the statute of limitations for tax refund claims is three years. The deadline for filing a refund claim with respect to severance paid in 2009 is April 15, 2013. A refund claim cannot be filed with respect to severance paid before 2009. 

Employers may file what is known as a “protective” refund claim—a claim where the right to a refund is contingent on future events and may not be determinable until after the time period for filing a refund claim expires (i.e., the resolution of Quality Stores). The process for filing a refund claim (protective or otherwise) is routine. A Form 941-X must be completed for each calendar quarter covered by the refund claim. The refund claim is made on the employer’s behalf for the employer portion, and on each employee’s behalf for the employee portion, of FICA. Accordingly, employers must attempt to contact each affected former employee and ask for the employee’s consent to pursue the refund claim on his or her behalf.

Protective refund claims need not include exact calculations and consents from affected former employees. However, before a protective refund claim can be paid, the employer must “perfect” the protective refund claim by identifying the actual disputed amount and attempting to obtain employee consents. Employers located in the Sixth Circuit should consider filing perfected refund claims, and perfecting any protective refund claims that are pending.

Employers should also consider protecting their FICA-tax refund rights by filing protective refund claims for 2010 to 2012 if severance was paid in connection with involuntary workforce reductions in those years.

What to Expect After Filing a Refund Claim (Protective or Otherwise)

Refund claims based on the Quality Stores decision may be denied by the IRS due to the split in the circuits or held without action pending resolution of Quality Stores.

If a refund claim is denied, the employer has two years to: (1) file a refund suit in court or (2) obtain an extension of the time to file such a suit with the IRS by filing a Form 907 “Agreement to Extend the Time to Bring Suit.” Employers who have received refund claim denials should keep the refund denial letters in their records and track the two-year deadline so that the employer can continue to preserve its refund rights by timely filing Form 907s.

Should Employers Continue to Pay and Withhold FICA Taxes on Involuntary Severance Benefits?

Given the uncertain future of the Quality Stores decision, employers should continue to pay and withhold FICA taxes on involuntary severance benefits that are not provided pursuant to a traditional supplemental unemployment benefit plan. If the Supreme Court declines to hear Quality Stores or hears and reverses the Sixth Circuit’s decision, employers that failed to pay and withhold FICA based on Quality Stores will be liable for both the employer and employee portions of unpaid FICA, plus interest and penalties.

Can My Company File Refund Claims Based on Quality Stores If We Do Not Have a Formal, Written Severance Plan or Policy? 

Not all employers that implement a severance pay policy adopt a formal, written plan or policy. It is uncertain whether a written plan is required. The Quality Stores decision does not specifically address the “plan” requirement because the parties agreed that the severance was paid pursuant to two written plans. However, employers that do not have a written severance plan or policy should not dismiss this refund opportunity based on that fact alone. It is possible that an informal policy may be considered a “de facto plan” or even an ERISA-governed plan, based on oral representations, the actual payment of benefits, the employer’s past practices, reasonable expectations of employees, or the intentions of the employer, particularly if the informal policy provides more than just a one-time, lump sum payment to a group of employees. If the Supreme Court upholds the Sixth Circuit’s Quality Stores decision, the next wave of litigation in this area may focus on the meaning of “plan” for purposes of section 3402(o) of the Internal Revenue Code.

Going forward, employers with informal policies that are anticipating providing involuntary severance payments in 2013 and future years should consider adopting a written severance plan or policy to eliminate any doubt as to whether severance is paid pursuant to a plan. Note, however, that adopting a formal severance plan could have ERISA implications.

Employers that anticipate providing significant involuntary severance payments in 2013 and future years may be able to achieve considerable additional savings by converting their formal or informal severance arrangement to a traditional supplemental unemployment benefit plan. I will be blogging about the differences between traditional supplemental unemployment benefit plans and severance plans in the next couple of weeks.